Inspiration from physics for thinking about economics, finance and social systems

Monday, November 18, 2013

Cleaning up finance? That WOULD be a surprise

Several things worth reading that give tiny rays of hope that one day we might get some regulations with real teeth to reform the financial system.

First, some remarks by Kenneth C. Griffin, the founder and chief executive of Citadel, giving his views that the big banks should be broken up, or laws changed to encourage the flowering of smaller banks with competitive advantages on the local level (he mentions in particular putting caps on the size of deposits).

Second, an essay by law professor Peter Henning who is a specialist in financial fraud and enforcement. He gives a look at how developments such as derivatives and high frequency trading have created a host of opportunities for sophisticated market manipulation, but also how some recent legal changes have given regulators more power to pursue actions even if they cannot prove "intention to manipulate."

Third, an extended article looking at how things are developing with the so-called Volcker Rule that would, ostensibly, prohibit investment banks from trading on their own proprietary accounts. This gives a mixed message, actually, and it even seems that some of the regulators are part of the problem. Look at the second sentence below:

Gary Gensler,
head of the Commodity Futures Trading Commission, also wants to make it
harder for banks to disguise speculative wagers as permissible trading
done for customers, according to the officials briefed on the
discussions. Underscoring the tension, other regulators privately
groused that Mr. Gensler’s agency — which spent most of the last few
years completing dozens of other new rules under Dodd-Frank — was too
slow to raise concerns about the Volcker Rule.

Finally, a great speech by Elizabeth Warren on why Too Big To Fail remains a very serious prpoblem even five years after the worst moments of the crisis. Some excerpts below:

Thank you, Americans for Financial
Reform and the Roosevelt Institute for inviting me to speak today.
I’ve been working very closely with both AFR and Roosevelt for
years now, and I’m really delighted to be here.

It has been five years since the
financial crisis, but we all remember its darkest days. Credit dried
up. The stock market cratered. Historic institutions like Lehman
Brothers and Merrill Lynch were wiped out. There were legitimate
fears that our economy was tumbling over a cliff and that we were
heading into another Great Depression . We averted that grim outcome
, but the damage was staggering. A recent report by the Federal
Reserve Bank of Dallas estimated that the financial crisis cost us
upward of 14 trillion dollars — trillion, with a t. That’s
$120,000 for every American household — more than two years’
worth of income for the average family. Billions of dollars in
retirement savings disappeared . Millions of workers lost their jobs
and their sense of financial security. Entire communities were
devastated. And a Census Bureau study that came out just a couple
months ago shows that home ownership rates declined by 15 percent for
families with young children. The Crash of 2008 changed lives
forever.

In April 2011, after a two - year
bipartisan enquiry, the Senate Permanent Subcommittee on
Investigations released a 635 - page report that identified the
primary factors that led to the crisis. The list included high -
risk mortgage lending, inaccurate credit ratings, exotic financial
products , and, to top it all off, the repeated failure of regulators
to stop the madness. As Senator Tom Coburn, the Subcommittee’s
ranking member, said: “Blame for this mess lies everywhere from
federal regulators who cast a blind eye, Wall Street bankers who let
greed run wild, and members of Congress who failed to provide
oversight.” Even Jamie Dimon, the CEO of JPMorgan Chase, has
emphasized inadequate regulation as a source of the crisis. He wrote
this to his shareholders: “had there been stronger standards in
the mortgage markets, one huge cause of the recent crisis might have
been avoided. ”

The crash happened quickly and
dramatically, and it caught our nation and apparently even our
regulators by surprise. But don’t let that fool you. The causes of
the crisis were years in the making, and the warning signs were
everywhere. As many of you know, I spent most of my career studying
the growing economic pressures on middle class families — families
that worked hard and played by the rules but still can’t get ahead.
And I’ve also studied the financial services industry and how it
has developed over time. A generation ago, the price of financial
services — credit cards, checking accounts, mortgages, and
signature loans — was pretty easy to see. Both borrowers and
lenders understood the basic terms of the deal. But by the time the
financial crisis hit, a different form of pricing had emerged.
Lenders began to use a low advertised price on the front end to
entice customers, and then made their real money with fees and
charges and penalties and re - pricing in the fine print. Buyers
became less and less able to evaluate the risks of a financial
product, comparison shopping became almost impossible , and the
market became less efficient. Credit card companies took the lead,
with their contracts ballooning from a page and a half back in 1980
to more than 30 pages by the beginning of the 2000’s. And teaser -
rate credit cards — which advertised deceptively low interest rates
— paved the way for teaser - rate mortgages. When I worked to set
up the Consumer Financial Protection Bureau, I pushed hard for steps
that would increase transparency in the marketplace. The crisis began
one lousy mortgage at a time, and there is a lot we must do to make
sure there are never again so many lousy mortgages. CFPB made some
important steps in the right direction, and I think we’re a lot
safer than we were.

But what about the other causes of the
crisis ? … Where are we now, five years after the crisis hit and
three years after Dodd - Frank? I know there has been much discussion
today about a variety of issues, but I’d like to focus on one in
particular. Where are we now on the “Too Big to Fail” problem?
Where are we on making sure that the behemoth institutions on Wall
Street can’t bring down the economy with a wild gamble ? Where are
we in ending a system that lets investors and CEOs scoop up all the
profits in good times, but forces taxpayers to cover the losses in
bad times? After the crisis, there was a lot of discussion about how
Too Big to Fail distorted the marketplace, creating lower borrowing
costs for the largest institutions and competitive disadvantages for
smaller ones. There was talk about moral hazard and the dangers of
big banks getting a free, unwritten, government - guaranteed
insurance policy. Sure, there was talk, but look at what happened:
Today , the four biggest banks are 30% larger than they were five
years ago . And the five largest banks now hold more than half of the
total banking assets in the country. One study earlier this year
showed that the Too Big to Fail status is giving t he 10 biggest US
banks an annual taxpayer subsidy of $83 billion. Wow . Who would have
thought five years ago , after we witnessed firsthand the dangers of
an overly concentrated financial system, that the Too Big to Fail
problem would only have gotten worse?

We should not accept a financial system
that allows the biggest banks to emerge from a crisis in record -
setting shape while working Americans continue to struggle. And we
should not accept a regulatory system that is so besieged by
lobbyists for the big banks that it takes years to deliver rules and
then the rules that are delivered are often watered - down and
ineffective . What we need is a system that puts an end to the boom
and bust cycle. A system that recognizes we don’t grow this country
from the financial sector; we grow this country from the middle
class. Powerful interests will fight to hang on to every benefit and
subsidy they now enjoy . Even after exploiting consumers, larding
their books with excessive risk, and making bad bets that brought
down the economy and forced taxpayer bailouts, the big Wall Street
banks are not chastened . They have fought to delay and hamstring the
implementation of financial reform, and they will continue to fight
every inch of the way. That’s the battlefield. That’s what we’re
up against. But David beat Goliath with the establishment of CFPB
and, just a few months ago, with the confirmation of Rich Cordray.
David beat Goliath with the passage of Dodd - Frank. We did that
together – Americans for Financial Reform, the Roosevelt Institute,
and so many of you in this room. I am confident David can beat
Goliath on Too Big to Fail . We just have to pick up the slingshot
again.

Search This Blog

This blogexplores the potential for the transformation of economics and finance through the inspiration of physics and the other natural sciences. If traditional economics has emphasized self-regulation and market equilibrium, the new perspective emphasizes the myriad positive feed backs that often drive markets away from equilibrium and cause tumultuous crashes and other crises. Read more about the idea.

Who am I?

Physicist and science writer. I was formerly an editor with the international science journal Nature and also the magazine New Scientist. I am the author of three earlier books, and have written extensively for publications including Nature, Science, the New York Times, Wired and the Harvard Business Review. I currently write monthly columns for Nature Physics and for Bloomberg Views.